In my last article, I explained how the income benefit base on an income rider can accumulate over time. The power of the roll-up rate during accumulation can build a strong future income base for your client. In this article, I want to explain how withdrawals work.

Before moving to withdrawals, though, I want to review annuity sales for 2009. Reports from LIMRA and annuityspecs.com show mixed results for 2009 annuity sales.

Total industry annuity sales for 2009 were down 11 percent at $234.9 billion

Variable annuity sales were down 18 percent for the year, at $127.0 billion

Fixed annuity sales were down 1 percent, with total sales of $107.9 billion

Fixed annuity sales were close to 2008's record, which saw total sales of $109.3 billion

Fixed indexed annuity sales hit a record of $30.1 billion, up 13 percent

Source: LIMRA

Even though equity markets were generally up for the year, the continued uncertainty in today's financial markets led to an increased number of consumers seeking fixed and fixed indexed annuity products to help supplement their retirement savings. The addition of income riders to these products has also improved sales for some carriers, who indicate that more than 50 percent of their annuity applicants apply for the optional riders.

LIMRA also reported that a guaranteed lifetime withdrawal benefit (GLWB) rider was elected in nearly 75 percent of the variable annuity contracts purchased in the fourth quarter of 2009, indicating that consumers are looking for the guarantees an annuity income rider can help provide.

Income choices

Customers can extract money from a deferred annuity in two ways. They can take partial withdrawals or they can annuitize their annuity and receive lifetime income. With choice one withdrawals, they can control their principal but they don't receive a lifetime income guarantee. With choice two annuitization, they gain lifetime income but they lose control over their principal. If, however, the customer elects a GLWB rider when they purchase their annuity, they'll receive a third option for extracting money from their annuity. With a GLWB, your customer can elect to receive lifetime income and still maintain control over their principal.

While in deferral, your customer is still in the accumulation period. During this period, the annuity's income benefit base will continue to grow at a specified roll-up rate. When your customer begins to take income from their annuity contract, they will transition from the accumulation period to the distribution period.

An income rider with lifetime payments can be likened to Social Security. With Social Security, if you wait longer to receive income, you're lifetime income check will be higher. The same holds true for lifetime income payments from annuity income riders.

Customers may find it difficult to determine the most appropriate time to begin lifetime income payments from their annuity. Most riders allow the accumulation in the income benefit base to continue growing, even if the customer takes a "normal withdrawal". Typically, a normal withdrawal comes out of the income benefit base on a "pro-rata" basis. Pro-rata basis is one of the most important concepts to understand when helping your client decide if they should turn on income under the terms of the rider.

Pro-rata withdrawals

Generally, pro-rata withdrawals work to the client's advantage when the following two things are true:

No. 1 -- The income benefit base is higher than the underlying annuity accumulated value

No. 2 -- The percentage amount of the normal withdrawal plus any rider charge is less than the current roll-up rate.

Here's an example where the customer turns on lifetime income under the rider but does not take normal withdrawals. These examples are hypothetical and only for educational purposes. The options available will depend on the particular provisions of the annuity policy terms. Any option selected should only come after careful consideration of the client's circumstances.

A client age 60 deposits $100,000 into an annuity with a 10 percent premium bonus. On Day 1, both the accumulated value and the income benefit base equal $110,000. In this example, the accumulated value will grow at a 2.90 percent fixed interest rate and the income benefit base will grow at 8 percent compound interest.

At the end of the first year:

The accumulated value is $112,850 after deducting the 0.30 percent charge for the income rider.

The income benefit base is $118,800. It has grown at a higher rate (8 percent compound interest) and does not incur a rider charge.

The client turns on lifetime income under the rider. They will receive $5,940 per year for life.

However, this may not be the most opportune time for the client to turn on income under the rider. At the end of the first year, the client could take a normal withdrawal instead of turning on lifetime income.

Here's a similar example, but this time the client takes normal withdrawals before electing to turn on income under the terms of the rider. At the end of the first year:

The accumulated value is $112,850 after deducting the 0.30 percent charge for the income rider.

The income benefit base is $118,800. It has grown at a higher rate (8 percent compound interest) and does not incur a rider charge.

The client takes a normal withdrawal from the annuity in the amount of $6,000, which is higher than the $5,940 they would receive per year if they began their lifetime income payments.

The $6,000 cash withdrawal is subtracted on a dollar-for-dollar basis from the accumulated value, which is 5.32 percent of the accumulated value.

The pro-rata withdrawal of 5.32 percent or $6,316 is deducted from the income benefit base.

Over the next eight years, the client continues to take a normal withdrawal of $6,000 each year. Each year a higher pro-rata withdrawal is subtracted from the income benefit base. Even though the client is taking annual withdrawals, the annuity's income benefit base continues to accumulate at 8 percent compound interest.

After nine years of taking withdrawals, which is the end of the 10th policy year, the client has taken normal withdrawals totaling $54,000. The income benefit base has grown to $124,968 and the accumulated value has fallen to $78,531.

Now the client has reached attained age 70 and can turn on income using the 6 percent payout factor, instead of 5 percent, which was the payout factor when the client was age 60. To calculate income payments at age 70, multiply the 6 percent payout factor by the income benefit base of $134,674. The lifetime income payment equals $8,080 per year.

By taking normal withdrawals and delaying lifetime income payments for nine years, the client in this example has increased their lifetime income payments by 36 percent.

Pro-rata withdrawals generally work best for clients ages 60-70 who want income from their annuity in the earlier years. They can be applied to non-qualified and qualified dollars. Clients do not have to take a series of withdrawals. Instead, they may take withdrawals for a couple of years and then go back into deferral.

Remember, in this example, if the client turns on income under the terms of the rider, the 8 percent roll-up rate stops. A client should take all these factors and their particular circumstances into account before beginning lifetime income payments.

If you would like to receive a consumer approved illustration to show this concept, contact me using the forum below and we can work with you to show the concept of pro-rata withdrawals. Sign up as a fan and you'll automatically receive future articles.

This article is not intended to give tax or legal advice and is for general educational purposes only. This article is for agent use only. Features and/or riders may not be available in all states or with all insurance carriers and may vary from state to state. Please check the product/rider disclosures and policy for actual terms and conditions. You are encouraged to seek independent legal and/or professional advice depending on your client's individual circumstances.

*For further information, or to contact this author, please leave a comment and your e-mail address in the forum below.

About the Author

Randy Timm, CLU, ChFC, FLMI, is Senior Vice President - Product Brokers International, Ltd. His 30 years of industry experience includes positions in marketing, underwriting, customer service, market research and product development. He has been an industry expert in marketing indexed life and... More